U.S. Is Expected to Fight
Move to Link Currencies

Tired of violent swings in currency markets, French, German and Japanese officials want to link the dollar, yen and euro in an effort to stabilize the global financial system.

But they're in for a fight trying to win the support of U.S. Treasury Secretary Robert Rubin and his deputy Lawrence Summers, who believe any such agreement would cripple U.S. economic policies, especially the use of interest rates to combat inflation or unemployment.

So far, the Europeans and Japanese are simply railing vaguely against "excessive volatility" in currency markets that has swamped economies from Thailand to Brazil over the past 18 months. The idea, however, seems to be to establish loose ranges limiting the movement of the dollar, the yen and the new 11-country euro. Should one currency rise or fall too far against the others, the Europeans, Japan and U.S. would intervene to correct the situation. Currently, nations intervene in currency markets unilaterally. Under the currency-zone plan, this would be done in concert.

"We aren't for fixed foreign-exchange rates, but for stable currency rates," German Finance Minister Oskar Lafontaine explained after meeting with his Asian and European counterparts earlier this month.

Japanese officials have been even sketchier, saying they don't support currency target zones right now but believe the idea deserves serious study.

Better Focus in Bonn

The proposals are likely to come into better focus in Bonn next month, when Mr. Lafontaine, France's Dominique Strauss-Kahn and Japan's Kiichi Miyazawa attend a meeting of finance ministers from the Group of Seven industrialized nations, and again at June's G-7 summit in Cologne, Germany. Both gatherings will concentrate partly on proposals to redesign the world financial system to stave off crises.

But U.S. officials, led by Messrs. Rubin and Summers and Federal Reserve Chairman Alan Greenspan, will almost certainly reject any plan requiring big powers to adopt preannounced limits on currency movements. And without the U.S., the proposal is doomed.

"My view of target zones really hasn't changed," Mr. Rubin said recently. "I think that there are practical questions of how you actually implement it, but leaving that aside, there is the much larger conceptual question of: Is it a good idea?"

The answer from Washington is a resounding no. It's not that the U.S. Treasury or Federal Reserve welcome volatility; a fluctuating dollar can fuel inflation or hurt U.S. steel companies that compete with foreign producers. Rather, the Treasury and Fed refuse to handcuff themselves to a currency policy that might, at times, hurt the U.S. economy.

Post-Cold War Skirmish

The debate isn't simply a theological one over how best to deal with financial instability. In a sense, it's a skirmish in the post-Cold War global-power realignment. With their new euro in hand, the Europeans -- especially the French -- want to assume their rightful place at the global economic table. The Japanese, now mired in the ninth year of an economic slump, are worried that the euro's arrival means they'll lose their status as the world's No. 2 economic player.

"All of the sudden the dwarves of Europe are asking whether Snow White always has to be the U.S.," says Norbert Walter, chief economist at Deutsche Bank AG in Frankfurt. "It's a question that comes quite naturally."

A three-way currency system would soothe national egos all around. But nationalistic motives are laid over deeper discord over how best to keep market volatility from crushing economic growth.

Mr. Lafontaine, named finance minister in Germany after September's Social Democratic Party election victory, has a taste for managed markets. And Japan's Mr. Miyazawa comes from a country with a long history of government intervention in industrial policy and exchange rates.

"Lafontaine and Miyazawa come from different approaches, but have a meeting of minds in their desire to take markets on a leash," says Thomas Mayer, senior economist at Goldman Sachs in Frankfurt.

Faith in Supply and Demand

The U.S., by contrast, puts much more faith in unfettered supply and demand. First, U.S. policymakers doubt that any bureaucrat really knows what the appropriate exchange rates would be. And with daily turnover in foreign-exchange markets estimated at $1.5 trillion, they're equally dubious that official intervention -- to alter the rate by buying or selling dollars -- could be large enough to keep exchange rates within target zones.

Those doubts have been echoed by European Central Bank President Wim Duisenberg, who said recently that there is "serious doubt whether target zones for exchange rates are feasible."

One alternative to intervention in currency markets is imposing controls on capital movements, which the U.S. opposes. Another alternative is using interest rates to influence exchange rates. Higher U.S. interest rates lure global investors to buy dollars, pushing up the dollar's value against the yen and euro. But monetary policy also has more important goals: fighting inflation and curing recessions.

U.S. officials are loath to surrender control over monetary policy just to keep exchange rates within agreed-to ranges. And, while the U.S. in the Rubin-Greenspan era does occasionally intervene in currency markets, Treasury officials generally believe that sound domestic economic policies are the best way to maintain stable exchange rates.

"I don't, at this point, see the circumstances in the next five years which would convince U.S. policymakers that [target zones are] the best option," says former White House economic adviser Daniel Tarullo, now a senior fellow at the Council on Foreign Relations in Washington.

But with the global economy now being buffeted regularly by unpleasant surprises, no option can be considered completely dead. U.S. exchange-rate policy, for example, has changed through the decades. During the Reagan years, the Treasury refused to brake the dollar's rise, then reversed course and helped push it down. In the early Bush years, the Treasury aggressively tried to keep the dollar steady.

"If we were to encounter additional periods of rapid and substantial fluctuations in the value of the yen against the dollar and the euro, then people might begin rethinking" their opposition to target zones, Mr. Tarullo said.